How Labor’s plans to revamp negative gearing could put a floor on house prices and lower rents

The economic policy debate over Labor’s plans to overhaul the negative gearing rules is hotting up.

It is an important debate on a policy change that will have implications for the housing market, particularly for first home buyer and investor demand.

The government is claiming that the negative gearing change will “take a sledgehammer”, “smash” and “punish” everyone in Australia. Treasurer Josh Frydenberg says that under Labor, “your home will be worth less and renters will pay more.”

It is a frightening scenario for property obsessed Australians with the value of all dwellings in Australia estimated to be around $7 trillion.

But is it true? What are the facts about the current housing cycle and how will Labor’s plans to revamp negative gearing impact the housing market?

Let’s first look at what Labor is pledging to do.

In simple terms, the negative gearing reforms will mean that it will no longer be possible to invest and negatively gear an established dwelling. The policy will, however, be grandfathered which means that those 1.3 million Australians who currently have a negatively geared established dwelling will still be able to use the existing tax laws. Their tax and investment strategies will be untouched by the change.

The change will reduce demand from investors for established dwellings. This means that a source of frustration for young and first home buyers of having to compete with investors at house auctions, for example, will all but disappear.Whether this leads to lower house prices is by no means clear.

To be sure, in isolation there will be downward pressure on prices as investors stay away from the market, but this will be offset, by an unknown amount, from the substantial pent up demand from those who have been frozen out of homeownership over many years.

With home ownership rates having fallen for the past two decades, the pent up demand for housing could be substantial, especially in the current low interest rate environment.

Rental impacts

It is important to note that in the past year where house prices have been falling as investor demand has fallen due to regulatory changes, the number of first home buyers has been increasing. Under Labor’s proposal, negative gearing will still be available for investors who buy new dwellings.

As investors inevitably take advantage of what will still be very generous tax and negative gearing rules, this switch in demand away from established dwellings is likely to underpin a lift in dwelling construction.

Another impact as first home buyers re-emerge and home ownership rates increase will be to see rents fall, not rise as Mr Frydenberg claims. The new buyers who by definition are renting now, will leave their rental premises and the supply of rental properties on the market will rise.

Basic economics tells us that rents will weaken in these circumstances. The effect of this interplay of changes in the housing market will take some years to work through the economy, but it is by no means clear or certain whether house prices will rise or fall as the changes in negative gearing rules come into play.

Various unknowns

It is interesting to note that under the current tax rules where negative gearing for established dwelling is available, house prices have been falling.

From peak levels, house prices have dropped 23 per cent in Darwin, 14 per cent in Perth, 8 per cent in Sydney and 5 per cent in Melbourne. Nationwide house prices have fallen more than 5 per cent.

This suggests that other factors are and will impact house prices, including a mix of macroeconomic conditions, unemployment, supply, demand, ease of access to credit, wages and interest rates. This is relevant because when Labor’s negative gearing rules take effect, these influences probably will be different to where they are now. Wages growth could be strong which would help to support demand for housing, regardless of the negative gearing rules.

If the RBA is right, interest rates could be higher, which would clearly add a cyclical downside to the housing market.

It is also possible, and perhaps likely, that the addition to the supply of housing will slow in line with the current slump on new building approvals which will be a factor supporting prices.

There are myriad issues, events, and factors that could swamp any effect of Labor’s changes to negative gearing.

To run a scare campaign that the change to negative gearing take a sledgehammer to the housing market is misguided and is not underpinned by any facts on the issues that drive housing markets.

Word has it that the framing of the budget, due to be handed down by Treasurer Josh Frydenberg the day after April fools day (and around 6 weeks before the election), is more problematic than usual.

Problematic because there is some mixed news on the economy that will threaten the current forecast of a return to budget surplus in 2019-20.

Housing has gone into near free-fall, both in terms of prices and new dwelling approvals. This is bad news for GDP growth. The unexpected severity of the housing slump is the key point that will see Treasury revise its forecasts for GDP growth, inflation and wages lower when the budget is handed down.

It will be impossible for Treasury to ignore the recent run of hard data, including the weakness in consumer spending and a generally downbeat tone in the recent economic news when it sets the economic parameters that will underpin its estimates of tax revenue and government spending and therefore whether the budget is in surplus or deficit.

The prospect that interest rates will be lowered within the next few months is already starting to impact on the economy.

Here’s how.

Around the middle of 2018, financial markets were expecting the RBA to hike official interest rates to 1.75 or 2 per cent over the course of the next 18 months or so. If proof was needed that investors and economists can get it wrong, markets are now pricing in official interest rates to be cut towards 1 per cent over the next 18 months.

The about face has been driven by a raft of disappointing news on the economy, most notably the fall in house prices, the free-fall in new dwelling building approvals and a slump in retail spending growth.

Business confidence has also taken a hit and job advertisements have been falling for eight straight months. Ongoing low inflation and increasing signs of a slowdown in the global economy have simply added to the case for this dramatic change in market pricing.